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Real Options - Coggle Diagram
Real Options
Introduction
Takes into account the dynamic flexibility of management being able to deal with uncertainty in timing and revising investment decisions to adapt its actions in response to future market conditions.
DEFINITION: Discretionary/Strategic opportunities/options implicitly embedded in firm's investment project.
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The valuation accounts the ability to account for information that arises as the project is in progress.
Identifying real Options
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Examine the pattern of cash flows and identify cash flows and big ticket item expenditure that may be discretionary.
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Key Terms
Exercise Price - Investment Outlay Costs (X)
Value of Underlying Asset - PV of expected Cash flows (V)
Exercise only if V>X